SMALL BUSINESS

OWNERS HANDBOOK
PART II:
FINANCIAL PLANNING FOR
SMALL BUSINESSES

Introduction
Financial Planning
Methods of Financing Your Business
Other Types of Funds & Financing
How to Approach Lenders

FINANCIAL PLANNING FOR A SMALL BUSINESS

Introduction
Financial planning is at the heart of every successful business. A financial plan,
which includes detailed financial statements and projections, forms the core of
your overall business plan. For more information on preparing a business plan, refer
to Small Business Owners Handbook Part I: Managing a Small Business.
Financial planning should be completed at least once a year and revised monthly to
incorporate actual results. It has two main purposes:
1. It enables you to make sound business decisions about what financial
resources your company actually needs, and about what financial moves your
company needs to make, to be successful.
2. It helps you plan for and obtain the necessary financing to establish your
business, continue its operation, and help it grow.
Solid financial planning demonstrates to potential investors and lenders that you
are planning for success and that you are serious, thorough, knowledgeable and
realistic.
In addition to impressing upon investors and lenders that you have done your
homework and thought through your financial plan, the actual plan allows them to
quickly evaluate the following:

The short and long term prospects for your business

Your company's profit potential

Your company's strengths and weaknesses

Future opportunities and challenges

The amount and type of financing your business will need to be successful

Remember!
This is the most important part of business planning and it is
recommended that you seek the services of a qualified
Business Consultant.

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Financial Planning
Your business plan will only be as strong as its financial plan. For your financial plan
to attract investors and be valuable as a business-planning tool, it must be based on
reliable numbers and careful calculations.
Your financial plan should include:
1. Project or Start-up costs (for new business and expansion of existing
businesses);
2. Projected Income Statement;
3. Projected Balance Sheet;
4. Statement of Financial Activities;
5. Cash flow projections;
6. A break-even analysis;
7. A ratio analysis;
8. Historical financial statements (for existing businesses).

Project Costs
If you are starting a new business, first determine start-up costs. These costs
include the one-time expenditures that your company must make before it opens its
doors for business. These costs are typically financed by personal or investor
equity (having 10% of your own cash is a rule-of-thumb), grants, and a small
business loan.
Funding needed to run a business (to keep it going once started) and pay for its
operational expenses (rent, utilities, suppliers, wages, interest, etc) is called
operating funding or working capital. Working capital is usually financed through:
the revenues the business generates or an established line of credit through a
commercial bank. However, if the business is unable to generate sufficient
revenues in the initial months of business, some of the operating costs can be
included with the project costs.

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Project or start-up costs include (not all costs may apply):

Fixed assets (land, building, equipment, furniture, fixtures, signage, etc.)

Inventory (enough for openingnot a years supply)

Business fees (loan, business planning, legal)

Insurance costs

Licenses, permits, and registration

Deposits for public utilities and telephone

Leasehold improvements or renovations

Franchise fee

First months rent

Labour costs for the first month

Marketing/advertising costs (grand opening, flyers, etc.)

Other (appraisal, environmental assessments, etc.)

Remember, total financing must equal total project costs.

Income Statement
An income statement presents your actual business revenues and expenses, the
difference between which is your company's net profit (or loss) over a specified
period. An income statement is sometimes referred to as a profit and loss
statement, an income and expenses statement, or an operating statement.
According to Canadian tax law, it must be completed at least once a year.
A projected income statement compares estimated revenue and expenses and then
calculates your estimated net profit (or loss) over a specific period. Potential
investors and lenders will want to see a projected income statement for at least
one, and possibly three years.
Revenues (Sales) Cost of Goods Sold = Gross Margin
Gross Margin Operating Expenses Depreciation = Net Income (before tax)

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Sales Forecasting
Forecasting sales is the starting point for financial projections, and the basis of
budgeting.
1. List all the products and/or services your business plans to sell in separate
units.
2.

Determine how many of each unit will sell (monthly and yearly). This
requires methodology (a logical tactic) by using historical information, a
marketing plan, traffic flow, and/or an estimation of your market share (by
assessing total demand to current supply).

3. Multiply the number of units that your business is forecasted to sell

(calculated in #1 above) with the price of each unit.

Cost of Goods Sold

These are the direct costs associated with the products that your business sells.
For retail, this includes cost of the product; for manufacturing, it includes the raw
materials purchased, the direct labour required to assemble the product, and the
direct overhead expenses. For service related businesses it includes the materials
required to properly deliver the service (fuel for truck drivers, hair solutions for
hairdressers, etc.).

Operating Expenses
Operating expenses can be divided into two categories (fixed and variable).
However, over the longrun most costs can be controlled and therefore variable.

Fixed Expenses are expenses that have to be paid regardless of sales levels and
include:

Rent

Utilities

Maintenance agreements (photocopier, internet access, fax, phone rental)

Insurance

Interest and bank charges

Professional fees

Property taxes

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Business licenses and memberships

Office supplies (vary depending on nature of the business)

Advertising and promotion (fixed if contracts are signed)

Variable Expenses are those that increase as sales increase or those costs that
management has control over and include:

Wages (for long-term sales trends)

Office supplies

Repairs and Maintenance

Fuel and vehicle expenses

Shop supplies

Telephone

Balance Sheets
A balance sheet provides a snapshot record, at a specific point in time, of
everything your business owns (assets), as well as what it owes (liabilities) and the
owner's equity.

Assets are things of value that the business owns:

Current Assets include cash, inventory, accounts receivable, and pre-paid
expenses.

Fixed assets include items with a useful life over one year, such as property,
equipment, and vehicles.

Liabilities are debts incurred by the company:

Current liabilities include the financial obligations for the upcoming year,
such as GST, PST, payroll and business income tax, accounts payable, the
principal (one-year) portion of mortgages and/or bank loans.

Long-term liabilities include the principal portion of mortgages and bank

loans beyond the next fiscal year, loans from shareholders, and equipment
leases.

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According to Canadian tax law, Canadian corporations must complete and file a
balance sheet at least once a year.

Net Worth or Retained Earnings is the balancing mechanism between assets

and liabilities and is the equity or worth of the business:

Assets Liabilities = Net Worth

Break-even Analysis
Break-even analysis allows you to calculate the amount of sales your business needs
to pay its fixed expenses. Your business' break-even point is where total costs
equal total revenues, and it is an important calculation in order to determine the
viability and profitability of your business.

A break-even analysis is based on three main factors:

Selling price:

For information on how to determine selling price, refer to

Small Business Owners Handbook Part III: Managing a Small Business.

Fixed costs:

These costs, such as rent, mortgages, equipment leases,

loan repayments, insurance, and core staff, do not change
as sales increase or decrease

Variable costs: These costs, such as additional staff salaries, the costs of
goods sold, supplies and materials, increase or decrease in
direct proportion to sales
Here is an example of a simple break-even calculation:
Barbara's Bowls:

Barbara produces and sells clay bowls for $40 dollars each. She calculates that the actual
(variable) cost to produce each bowl in labour, supplies, and materials is $30. This means her
gross profit on each bowl is $10 ($40 minus $30).
She has calculated that her fixed monthly costs, such as rent, utilities, and equipment are
$1,000. This $1,000 must be paid whether or not she produces any clay bowls.
To calculate how many bowls she must sell each month to break even, she divides her fixed
costs ($1,000) by her gross profit ($10) or 100 bowls to break even.

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Cash Flow Projections

A cash flow projection or forecast is an estimate of when you expect to receive
cash from your sales and, therefore, when you expect to pay bills. It is a critical
part of your financial planning and business plan because it shows how much money
will flow into and out of your business each month. Cash flow projections are
usually done for each month and at least one year into the future.

A cash flow projection is an important management tool because it

does the following:
1. Estimates the amount of money necessary to finance month-to-month
business operations.
2. Enables you to plan for the times when revenue will not be sufficient to
cover expenses.
3. Demonstrates to potential lenders that you expect to have sufficient
revenue to repay loans on a regularly scheduled basis.
4. Can be used to compare estimated and actual cash flows on a monthly basis.
This will allow you to constantly adjust your cash flow projections and
identify potential problem areas.

Business Ratio Analysis

There are a number of business ratios which potential lenders and investors will use
in order to assess the relative health of your business. Ratio analysis is a useful
management tool because it helps identify positive and negative trends in your
business performance.
The data for your ratio analysis comes from your balance sheet and income
statement. Your ratios should be compared to the ratios of similar businesses,
which can be obtained from industry associations, business libraries, or your lender.
Ask your accountant or business advisor to help you calculate ratios relevant to
your business. One example is the current ratio, others include return on sales,
return on assets, and debt to equity.

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Methods of Financing Your Business

Once you've completed your financial calculations, statements, and projections, you
will have a clearer idea of how much money you need to raise to finance your
business. The two main ways of financing a business are equity financing and debt
financing.

Equity Financing
Equity capital is the amount of money that you and/or your partners put into the
business. Equity is not debt (loans). While investors share in the profits (or losses)
of the business, their investment is not a loan. The following are a few suggestions
on how to raise equity:

Selling personal assets

Reducing personal spending to make money available

Savings or selling investments, bonds, RRSPs

Investors

Friends or family

Remember that to attract investors (shareholders) or partners, you must be able to

demonstrate both the profitability and the reasonable risk of your business
venture. The best way of doing this is through solid financial planning. Financial
planning is discussed in chapter One of this publication. For information on
preparing a business plan, refer to Small Business Owners Handbook Part I:

Starting a Small Business.

Consult a lawyer and your accountant before you enter into any shareholders
agreement with other investors.

Comparing Equity and Debt Financing

Before deciding on what combination of equity and debt financing you will use to
fund your business, consider the relative advantages of each:

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Advantages of Equity:

Advantages of Debt Financing:

Equity financing is not a loan and

doesn't have to be quickly repaid
(with interest)

If your business succeeds, you

won't have to share the profits
with partners or investors

You can increase your business'

debt financing ability by
increasing its equity

You will maintain independence and

control over how your business is
run

Reducing debt obligations lowers

cash flow risk (lower loan
payments are easier to pay)

Small Business Loans

With your equity capital in place, you are now in a position to approach lenders for a
business loan. Debt capital is the money your business borrows. While lenders do
not share in business profits as investors do, they must be repaid with interest
whether the business is showing a profit or not. Available to Metis individuals:

SaskMtis Economic Development Corporation: www.smedco.ca

Business Development Bank of Canada: www.bdc.ca

Commercial banks (call your local branch office)

Credit Unions (call your local branch office)

Women Entrepreneurs (Regina and Saskatoon):

www.womenentrepreneurs.sk.ca

Community Futures (call your local branch office)

Northern Enterprise Fund (for northerners): www.nefi.ca

Northern Development Fund (for northerners):

www.fnmr.gov.sk.ca/northern

Canadian Youth Business Foundation: www.cybf.ca

Farm Credit Canada: www.fcc-fac.ca

As a small business owner/operator, you should familiarize yourself with the
lenders' requirements before determining the type and the source of your
debt financing.

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FINANCIAL PLANNING FOR A SMALL BUSINESS

Other Types of Funding and Financing

Government Programs
The following are applicable to Mtis individuals:

Clarence Campeau Development Fund: www.clarencecampeau.com

Northern Development Fund (Northerners): www.fnmr.gov.sk.ca/northern

Aboriginal Media Arts Grant Program: www.canadacouncil.ca/aboriginal

Aboriginal Peoples Music Program: www.canadacouncil.ca/aboriginal

Canadian Youth Business Foundation: www.cybf.ca

Internal Source Comparing

Another source of money you can use to finance your business, and one that may be
overlooked by many small business owners, comes from internal resources of the
business itself. Tighter management controls can reduce the need for external
capital.

Other Sources of Financing

Leasing Fixed Assets
Many small businesses are leasing rather than buying their fixed assets, such as
land, buildings, and equipment. By leasing, your business can acquire the fixed
assets it needs by merely committing itself to rental payments, without making
substantial cash payment or incurring a large financial obligation. Although this
policy may appear more expensive over the long run, it means the business will have
more operating (working) capital available for current expenses and growth.

Leasing Equipment
Equipment leases are usually written on the total selling price of the equipment and
are drawn up for a period of three to five years. The total amount paid includes the
selling price plus finance charges. It is generally to your advantage to lease
equipment in the following situations:

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You are rapidly expanding and need all available working capital to increase
inventory, hire more staff, or expand plant facilities

The cost of new equipment is high and you do not have the cash available.
The equipment needs to be replaced frequently, often because of
technological advances

The equipment is used infrequently or temporarily

Before deciding whether to lease or to buy equipment, develop a cash flow forecast
for each option and consult with your accountant. Consider each lease or purchase
separately, look at the alternatives, and pick the one that best suits your needs.

Vendor Financing
At times, the selling person or party will lend the buyer the money. This method is
treated just a small business loan with interest and scheduled payments.

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How To Approach Lenders

Most people are apprehensive about approaching a financial institution for a loan. To
help you feel more comfortable about approaching your lender, it is useful to
remember the following:
1. In order to make money, the lender needs your business.
2. It is in the lender's interest to see your business succeed and grow.
3. Your lender is in business to extend credit provided your business is
profitable and produces sufficient cash flows to repay its debt obligations.
4. Venture is sound and profitable and represents no more than a reasonable
risk to the financial institution.

Some Key Questions Before You Borrow

Before approaching your financial institution, you should identify your actual loan
requirements by answering some key questions.

Does Your Business Really Need to Borrow Money?

Some small businesses, particularly small service businesses with low start-up and
operating costs, do not need to borrow money because of the following reasons:

A monthly basis, they take in enough money to cover expenses, or

Money they (and others) have invested in the business provides the
necessary financing

However, most small businesses, at some point in time, need to borrow money to do
the following:

Finance start-up costs and negative cash flows until the business is well
established

Finance business growth and expansion until customer demand for the
business' product or service increases

Fill a need for working capital to cover operating expenses, such as rent,
wages, and inventory purchases

Finance major capital expenditures, such as buildings, land, and equipment.

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What Lenders Are Looking For

There are no hard and fast rules that determine which loan applications are
approved and which ones are rejected. Part of a lender's decision is based on the
impression you make in the interview process. Nevertheless, there are some facts
your financial institution will look at when evaluating your application.

These include all of the following:

1. The managerial skills, background and experience of you and your
management team.
2. Your current assets, such as inventory and receivables, for security for
short-term loans.
3. Your fixed assets for security for long-term loans.
4. Any personal financial guarantees you are willing to make.
5. How much money you have invested in the business.
6. The business' overall debt to equity ratio.
7. Your ability to repay your loan based on cash flow projections.
8. Your business' past financial performance and current reputation.
9. An assessment of the long-term feasibility and profitability of your
business.
10. The long-term prospects for the industry you are in.
11. You and your business' track record in repaying loans (your credit record or
credit rating).
Be prepared to provide your personal net worth statement.

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Establishing a Positive Relationship With Your

Lender
The first step in establishing and maintaining a positive working relationship with
your financial institution is to choose one you are comfortable with and which meets
the needs of your business.
Find out which financial institutions are knowledgeable about your type of business,
and ask the owners of other small businesses who they would recommend. If
possible, try to arrange a brief meeting with the managers of the financial
institutions you think would be the best fit for your business.
Once you've chosen a financial institution, it's important to work at developing a
positive, long-term working relationship. Your lender can be an excellent source of
expert advice, offering you guidance and insight into how to structure and run your
business to ensure the greatest return on your investment. It is also in the best
interest of your financial institution to make sure that your business grows and
prospers.

Here are some tips on establishing and maintaining a positive and

mutually beneficial working relationship with your financial
institution:

Have a business plan and discuss it regularly with your account manager

Keep your account manager informed about what is happening in your

business, both good and bad. When a problem occurs, discuss it openly with
your account manager

Never surprise your financial institution. Plan ahead. Let them know in
advance if you're going to miss a loan payment, or if, for example, you need a
short-term loan to cover payroll while you're waiting for a major payment
from one of your customers

Evaluate your financial relationship yearly or if your financial situation

changes unexpectedly

Have regular meetings with your lender and if appropriate, invite their
representative to your business premises

If your lender is transferred, make an appointment with the new manager to

establish a personal relationship

Observe your financial institution's policies, and make loan payments on time

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Keep your financial records clear, accurate, and up-to-date and submit them
regularly and on time to your financial institution

Be honest, frank, and realistic when discussing your cash flow projections
and update them on a monthly basis.

Understanding the Loan Approval Process

When you borrow money, you enter into a contractual obligation. Many of the major
commercial lenders have streamlined their loan approval process to provide faster
service for their clients. In order to help speed the process, you must provide your
financial institution with sufficient information to prepare and assess your credit
application in detail.

The Interview
When applying for a business loan, the first step - the initial presentation to your
account manager at the financial institution - is crucial. Make an appointment so
that your account manager is ready to see you. Make sure you bring your business
plan, and be prepared to discuss it in detail. Make sure you understand and can
explain the financial statements and projections. For complete information on
preparing a business plan, refer to Small Business Owners Handbook Part I:

Starting a Small Business.

Be prepared to explain:
1. How much money you need and how you plan to spend it;
2. How the money will help your business grow and prosper;
3. How much money you can afford to pay back on a regular basis (based on
your cash flow projections);
4. What you plan to use as collateral, including personal guarantees you are
willing to make;
5. How you are prepared for a worst case scenario (for example, sales volumes
do not materialize or clients delay payments).

In the interview, your account manager will be assessing the

elements of your business plan and your management strengths and
weaknesses, including the following:
1. Your level of expertise and experience;

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2. Your professionalism and presentation skills;

3. Your level of commitment and enthusiasm.
To create a good impression, you should be well prepared, enthusiastic, and
professional.

If Your Application is Rejected

If you are turned down for a business loan, it is likely for one of
the following reasons:

Your business plan was incomplete

Your presentation was unprofessional

There is not enough equity in your business

Your cash flow is insufficient to ensure regular repayment of the loan

Your business, or the industry your business is in, appears too risky or
unpredictable

Your management team lacks the necessary abilities and/or experience

You cannot supply enough security for the loan

If your application is rejected, try to find out why. What areas of the application
were weak? What information was missing or required further clarification?

You now have several options:

1. You can rethink your proposal and try again;
2. You can consider other forms of financing;
3. You can wait until your business' financial performance improves before
reapplying.
Try not to get discouraged. A majority of small business clients who are turned
down by their banks are able to obtain other sources of funding.

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Why Business Loans Sometimes Become

Problem Loans
Despite the best of intentions, some small businesses run into serious financial
difficulties and are unable to repay their loans as scheduled.

If a business has run into financial problems, it could be for any

combination of the following reasons:

Poor or non-existent business planning, budgeting, and record keeping

Too large a debt load

An increase in sales has caused you to lose contact with your most important
customers or has caused product quality and service to deteriorate

Increased competition or decreased consumer demand for your product or

service

Unrealistic cash flow projections, decreasing cash flow, or poor planning

around cash flow projections has resulted in a decrease or disappearance of
working capital

A person essential to the success of the business dies, retires, or moves on

Poor management of inventory and/or accounts receivable has resulted in too

much capital being tied up in these assets

An inability to delegate responsibility results in one person trying and failing

to do it all

The business loses one of its major customers

If you have a close working relationship with your lender, renegotiating the terms
of the loan repayment will likely go more smoothly.

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